Picking through the driftwood to see why it sunk…

Archive for May, 2011

—–The US political scene is awash with deficit hawks issuing the clarion call of inflation. The rising price of food and oil is admittedly eating away at the living standards of the lower classes, also known as the majority of Americans, while other prices are more stable. The republicans and much of the economic elite are pointing a finger squarely at the federal government, claiming that the deficit and the Federal Reserve’s loose monetary policy is increasing the money supply in the US economy to hyperinflation levels. The logical extension of this argument is, of course, that the US government must cut spending, and the federal reserve must raise interest rates, halting attempts by the government to fix the economy and let it renew its “natural course”. This argument might seem persuasive at first: the government is printing more money, so the value of that money goes down, there causing prices to go up. A look at the actual data, however, shows that this argument is nothing more than a veil for another talking point against the government social security net, a distortion of the truth for political gain.

—–It is certainly true that the prices of some key goods in the US have risen. Headline inflation has risen to nearly 3% as of April, and food prices, if they continue at current rates, would increase almost 8% to as much as 20%, depending on who you ask, by this time next year. This is grim news for many Americans, particularly since the poorest 20% of us spend 44.1% of their income on food. However, the 3% number is what economists call headline inflation – presumably because it looks more shocking on newspaper headlines. The US government has a second number, known as core inflation – and that was only at 1.2% in March of this year! This low level of inflation is considered by some to be too low, in fact – many economist would like it to be higher. Once food and gasoline is excluded, the inflation disappears.

—–At this point the objection many quite fairly give is “so, who cares?” Food and gas are some of the most bought goods by middle and low income Americans, if they are going up in price it doesn’t matter if computer prices are going down. “I cant eat a iPad”, as it was said. Of course, rising food prices is horrible – but it isn’t inflation. Inflation is not the rising price of goods – its the falling price of the dollar. Think of the US dollar as a commodity just like any other. If the quantity of cars in the world doubled overnight, their price would go down – not just relative to the dollar, but also to other goods! Before I could get 10 computers for one car, now I could only get 5. Inflation is the same process happening to the dollar. If the dollars is actually suffering inflation, its price relative to all goods has to go down, meaning the price of all goods has to rise more or less equally. Today, given that only food and gas are increasing, that isn’t a problem with the US dollar – its a problem with gas and food. And the evidence bears this out. If the US dollar was weakening, why has gas in Europe, where they use the Euro, increased from €30 in 2008 to nearly €90 euros today? If the US dollar was weakening, why would food prices in England, which uses the pound, be increasingby 4.5% a month, an annual rate of over 50%? Once all the evidence is in the picture, its obvious – there is something wrong with the supply of food and oil, not the supply of US dollars. The sources of these problems are also obvious, with so much instability in the middle east and massive droughts in China and elsewhere. And until someone can explain to me how the US cutting spending on healthcare for the poor will lower the price of food in the United Kingdom, or how the Federal Reserve raising interest rates will somehow boost oil production in Saudi Arabia, any argument to change fiscal or monetary policy on the basis of these price increases is simply asinine.

—–There is one error in thinking that I believe many Americans may be making – given that we know the federal government’s deficit has increased so much, and the federal reserve is printing so much money, why hasn’t there been more inflation? If the supply of money is growing so fast, shouldn’t its value be collapsing, just like the value of cars? The answer is essentially “maybe”, because inflation is not simply the supply of money. Inflation is determined by what is often called the velocity of money. What that means is inflation is not caused by more money existing on a given day, it is caused by more money being spent on a given day on goods. If the government doubled the amount of US dollars in one day, but took that money and put in a vault underground, would it cause inflation? Of course not – as far as prices for food are concerned, that money doesn’t even exist! It isn’t being spent.

—–That is essentially what is happening today. All the money being printing by the government? Its going into treasury bonds, bought up by corporations, banks, and hedge funds, who we all know aren’t spending a dime. All this new money is going into financial products and saving accounts. It isn’t buying goods in the real world. While there are ways for investments like these to affect consumer goods prices – I wont say that government policy has had no affect at all on food prices – overall little of this money is entering the consumer markets. Which suggests that the government, far from decreasing spending, should be increasing spending massively, since our economy is still reeling, with no jobs and little growth, while inflation is not a concern at all.

—–The key thing about all this is that, honestly, this is common knowledge to those who study economics. Of course the average American does not and will not know this, but reporters and politicians, if they have any ounce of intelligence, should know this is how inflation works! Therefore, the calls by republicans and their elite allies to reign in “inflation” are either made out of idiocy or intentional duplicity. Honestly, I don’t see why a whole lot of both cant be the reason.

—–There has been a “fashion” of late on the blogosphere, both left and right, to re-evaluate US economic growth in the 21st century with the “new” insights on how much the American consumer was in the red. Both the Exiled and Zero Hedge have picked up this idea. Essentially, the logic is follows: GDP is not a measure of production, but of spending (which is true, its C+I+G+{EX-IM} – here the C is spending). In the US from 2000 to 2008, huge percentages of consumer spending, some of the highest levels in history, came not from income, but from loans taken to finance the spending. As such, if you are trying to discover the growth of the US economy (as opposed to growth in spending), then you need to discount debt-financed consumer spending. Once you do that, you discover that US GDP has not grown since 1998! People often talk about Japan’s lost decade in the 1990’s – from this perspective it looks like US decided to follow Japan’s lead.

—–This analysis is not bad, by any stretch. Its a very valid point to make, that debt financed consumer spending has really gone out of control and is distorting our economic figures. This analysis, however, does not prove what people think it proves. Ironically, proponents of this view are making the same exact mistake they accuse the “official” statistics of making – forgetting what GDP measures. Most people use GDP as a shorthand for “economy”, but it isn’t that, its a shorthand for spending. This shorthand works because people have to spend money on something, on making people produce something. Spending money allows people to fulfill a need. And honestly, it doesn’t much matter where that money comes from. Sure, debt-financed spending might not be sustainable – but it still boosts production. If a million people took out loans to buy a pickup truck each in a year, it would be a woefully bad use of loans, but the US would still have to produce one million pickup trucks to meet the demand. As such, by the standard of what people want to evaluate when they say economy – how much a country produces – the debt-financed spending still boosts output. Now, a lot of this debt went into the housing bubble, which is wasteful, since it was paying twice as much as people used to for the same good – but good GDP estimates take that into account. GDP adjusted for inflation (since the rise in the price of goods would be inflation) is one such way, but the Bureau of Economic Analysis, which does the official GDP statistics, re-evaluates GDP figures form the past when changes like this occur.

—–All of this does have a larger point. All of this debt-financed spending is resulting in economic growth – its fulfilling real needs. The problem isn’t, therefore, debt-financed spending. The problem is that people lack the income to fulfill their needs. If wages, which have been hopelessly stagnant compared to productivity, were to be increased, this previously “unsustainable” level of spending would suddenly become natural. From an economic standpoint, we want people to spend (at least to a certain point) and we should be working to allow that, not working to reducespending back to 1998 levels. Phrased another way, our economic output hasgrown, but us median income has not.

—–As a final note – don’t construe this article to say that A: all debt financed spending is good or B: that GDP is a great measure of economics. A lot of debt financed spending was wasteful and foolish, while GDP as a measure has more inconsistencies than the Bible – and is worshiped about as fiercely. Im just rebutting a particular critique from a particular angle.

—–If you are hunting for an amalgamation of every stereotype and myth purported as true by the privileged, The Economist is pretty much your intellectual Walmart – all of your needs satisfied at one local! Recently they had a blog post, responding to an asinine propaganda stunt by some budding libertarian, who asked college students if they should “redistribute grades”. Of course, he waited for them to say “of course not” before slamming them with his gotcha moment and murdering the very concept of appropriate analogies at the same time by claiming they must therefore oppose income distribution. The metaphor is too silly to even discuss, but a buried assumption in The Economist’s response is much more interesting, “In the very worst schools in America, some students have 3.0 GPAs, even though the students who earn a 3.0 GPA in those schools would be hard pressed to maintain a 1.0 GPA in America’s best schools. Work for which students receive B’s in poor schools would earn failing grades in top schools.”

—–The implicit assumption here is quite spectacular – you can tell the author did no research of any capacity, this was simply assumed true, “common knowledge”. Of course, its real truth value resides somewhere around birther conspiracies and the idea that anyone loves you. One, the statistical evidence doesn’t bear this out. While its really hard to analyze the results of education,tests show that for all colleges in the US, very few learn any demonstrative knowledge improvements. From another perspective, Ivy League schools in most cases don’t give one a noticeable income improvement – if you were smart enough beforehand to be accepted into the school, but choose not to go. Finally, a quick look at the actual grades in these schools shows how silly an idea this is – at Harvard in 2002, 50% of all grades were an A (not an A-, an A), and 80% graduate with honours – compared to a 50% at Yale. Honestly, though, this exercise is a bit useless – anyone who has actually been in college knows how silly this claim is. Your grades in college are impacted so much more by things like professors you choose, the major you choose, the lab partners you choose, and dozens of other factors. While of course individual schools vary, individual professors and programs and college experiences vary so much more.

—–The obvious fact that the quality of education at Harvard is no greater than at most state universities isnt the point, though – its the buried assumption here. Its ties into the whole ideology of market capitalism, of meritocracy. The education at the Ivy League has to be better than the education at other schools, otherwise the free market is utterly failing – since people pay large sums of money for that “better” education. And if, as it turned out, people weren’t paying for knowledge, but for a status marker that showed them worthy of high paying jobs, then the entire idea of meritocracy dies too – why do so many job applications list “Ivy league only need apply”if there is no qualitative difference in the education? The entire edifice of the Anglo-American economic order needs this fact to be true, so badly, as from it comes the pixie dust for the magic spell that lets them wave their wands and silence anyone who suggests that people being paid 500 times the average salary of their worker don’t deserve it.